ETFs And The LIBOR Scandal

by on July 27, 2012 | ETFs Mentioned:

Some are calling it the banking industry’s “tobacco moment,” while others insist that it is only one example of the widespread and rampant problems plaguing the financial universe. Greed, corruption and collusion are terms often used synonymously with the market movers and money makers on Wall Street, whose voracious appetites seem to blur the lines of morality and ethics. The sensationalism surrounding the LIBOR scandal has spurred the masses to raise their metaphorical  pitchforks once again, calling for judicial action, stricter regulations and more aggressive reforms. As everyday traders and investors fall victim to the unscrupulous acts of LIBOR’s manipulators, many are left wondering how this seemingly abstract issue will affect their very real-life coveted investments [see also How To Lose Money Trading ETFs].  

The Culprits

The manipulation of arguably one of the most important figures in finance actually started several years ago. Although no one knows exactly when it began, a vast array of revealing evidence have periodically surfaced over the years, pointing to the British powerhouse bank Barclays as one of the biggest culprits. Traders were well-documented in their attempts to rig LIBOR; one trader had even offered coffee in exchange for a fixed number, while another exclaimed “Dude. I owe you big time!” and celebrated his success with a pricey bottle of Bollinger champagne. Experts now believe that the net of exploiters spills across Britains’s boarders, deep into the United States, Canada and the European Union. Some of the most notorious names in finance are now under investigation, including Citigroup, JP Morgan Chase, UBS, Deutsche Bank and HSBC. And as the damning evidence continues to pile up, investors are now beginning to realize the global significance of this issue.

The $800 Trillion Rig

To begin to explain just how much of an impact this scandal will have on the financial world, we must first take a close look under the hood of the infamous figure. The London Interbank Offered Rate (LIBOR) is the interest rate at which banks can borrow funds from other banks in the London interbank market. More importantly, it is the rate upon which rates for most average borrowers are based. Perhaps the best way to visualize the impact of this scandal is through the numbers. The Economist estimates that LIBOR “is used as a benchmark to set payments on about $800 trillion-worth of financial instruments, ranging from complex interest-rate derivatives to simple mortgages. The number determines the global flow of billions of dollars each year.” The result – a flawed figure – determining the fate of trillions of dollars and, more importantly, the fate of nearly every average investor around the globe [see also Ex-Financials ETFs For Cautious Bulls].

ETFs Fall Victim

And because of our highly interconnected financial universe, the ETF space and its investors have also been subject to LIBOR’s manipulators. Below we outline several exchange-traded products that may have been impacted by arguably one of the worst scandals of the banking industry:

  • Senior Loan Portfolio (BKLN): This ETF is designed to measure the performance of the largest institutional leveraged loans based on market weightings, spreads and interest payments. Besides the fact that many of its holdings may be loans directly impacted by LIBOR, BKLN’s underlying index actually tracks the current outstanding balance and spread over LIBOR for fully-funded term loans.
  • Market Vectors Investment Grade Floating Rate Bond ETF (FLTR): This fund tracks a benchmark that consists of dollar-denominated floating rate notes issued by corporations. A number of FLTR’s floating rate securities are pegged to LIBOR.
  • Floating Rate Note Fund (FLOT): Similar to FLTR, this ETF also is designed to the performance of U.S. dollar-denominated floating rate notes, whose interest rates are often based on LIBOR [see Better-Than-AGG Total Bond Market ETFdb Portfolio].

To be clear, the above products weren’t necessarily impacted negatively, and there was certainly no nefarious action by the issuers. But as LIBOR was manipulated, it’s very likely that the value of some of the securities that make up these ETFs were impactedin some way–yet another illustration of how ubiquitous ETFs have become. 

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Disclosure: No positions at time of writing.